House Call

In the realm of trading, particularly in the context of brokerage accounts and margin trading, the term “house call” refers to a margin call that is initiated by a brokerage firm, rather than as a direct result of exchange-mandated maintenance margin requirements. Understanding house calls is essential for traders who use leverage to amplify their positions in financial markets.

Margin Trading and Leverage

Margin trading allows traders to borrow funds from their brokerage firm to purchase more securities than could be normally achieved with their available capital. This leverage can significantly amplify potential returns, but it also increases the risk of substantial losses. Traders are required to maintain a minimum account balance, known as the margin requirement, to continue using borrowed funds.

Types of Margin Requirements

  1. Initial Margin Requirement: This is the percentage of the purchase price of securities that the investor must pay using their own funds when buying on margin. It is set by the Federal Reserve Board’s Regulation T in the United States, which currently requires an investor to fund at least 50% of the purchase price.

  2. Maintenance Margin Requirement: This is the minimum account equity that must be maintained on an ongoing basis. It is a lower percentage compared to the initial margin requirement, usually set at 25% by FINRA, though individual brokers can impose higher requirements.

Margin Call

A margin call occurs when the equity in a margin account falls below the maintenance margin requirement. To satisfy a margin call, the trader must either deposit additional funds or securities into the account, or sell existing securities to reduce the loan balance. There are generally two types of margin calls:

  1. Regulatory Margin Call: Triggered by the exchange when the account equity falls below the legally required maintenance margin.

  2. House Call: Issued by the brokerage firm itself, based on its own, often stricter, margin requirements.

House Call: Detailed Examination

A house call is an internal margin call initiated by the brokerage firm due to its in-house risk management policies. It acts as a safeguard to ensure that the brokerage firm does not incur significant losses due to the client’s trading activities. Brokerage firms often have margin requirements that are more stringent than those mandated by regulatory authorities. Here’s how house calls typically function:

Reasons for House Calls

How House Calls Work

  1. Determination: The brokerage firm’s risk management team monitors account balances and assesses the risk exposure of margin accounts continuously.

  2. Threshold Breach: If a client’s account equity falls below the brokerage’s internal margin requirement, a house call is triggered.

  3. Notification: The brokerage firm notifies the client of the house call, typically through electronic communication methods, detailing the required actions to cover the margin deficiency.

  4. Action Required: The client must take immediate action to restore their account equity to the required level. This may involve depositing additional funds, transferring in securities, or liquidating existing positions to reduce the borrowed amount.

  5. Forced Liquidation: If the client fails to meet the margin call within the specified timeframe, the brokerage firm may liquidate sufficient assets from the account to cover the deficiency and bring the account back into compliance.

House Call Example

Imagine an investor, Alex, who holds an account with a brokerage firm that has a house maintenance margin requirement of 35%, higher than the regulatory requirement of 25%. Suppose Alex owns $100,000 worth of securities purchased with $50,000 of their own money and $50,000 borrowed from the brokerage (initial margin of 50%).

Due to market fluctuations, the value of Alex’s securities drops to $70,000. Alex’s equity in the account is now:

[ \text{Equity} = \text{Current Value of Securities} - \text{Loan Amount} = $70,000 - $50,000 = $20,000 ]

The equity percentage is:

[ \text{Equity Percentage} = \left( \frac{\text{Equity}}{\text{Current Value of Securities}} \right) \times 100 = \left( \frac{$20,000}{$70,000} \right) \times 100 \approx 28.57\% ]

Since the equity percentage (28.57%) is below the brokerage’s house maintenance margin requirement of 35%, a house call is triggered. The brokerage firm requires Alex to increase their equity percentage back to at least 35%.

The required equity to meet the house call is:

[ \text{Required Equity} = \text{Current Value of Securities} \times \text{House Maintenance Margin} = $70,000 \times 0.35 = $24,500 ]

Alex needs $24,500 in equity but currently has $20,000, so they must deposit an additional:

[ \text{Additional Funds Required} = \text{Required Equity} - \text{Current Equity} = $24,500 - $20,000 = $4,500 ]

Alternatively, Alex could reduce the loan amount by selling some of the securities.

Implications of House Calls

For Traders

For Brokerages

Leading Brokerage Firms with House Call Policies

Several well-known brokerage firms have their own house margin call policies. Some examples include:

Each of these firms provides detailed information about their margin requirements, including initial and maintenance margins, and the procedures followed when a house call is triggered.

Conclusion

In summary, a house call is a specific type of margin call initiated by a brokerage firm based on its in-house margin requirements, which are often more stringent than regulatory requirements. These calls play a crucial role in risk management for both traders and brokerages. By maintaining higher levels of equity in margin accounts, brokerages can protect themselves from potential losses in volatile markets, while traders are compelled to engage in more disciplined risk management practices. Understanding the nuances of house calls and the specific policies of brokerage firms is essential for anyone engaged in margin trading to avoid unexpected liquidations and maintain a sustainable trading strategy.